Will iPhone Growth Return For Apple?

Apple can still grow its iPhone sales by stealing market share from competitors

We go through some scenarios explaining the possibility that the iPhone may have reached its ultimate sales trend.

The European law suit will be drawn out over many years and will ultimately not affect Apple’s financials much

The smartphone industry is facing significant challenges, like saturation in developed markets including the U.S, Western Europe and China, where shipment growth is decelerating. This has caused many players to embrace emerging markets, where affordable, feature-rich phones pave the way to capture sales. The decline in upgrade rate due to the death of compelling new hardware innovations and the abolition of two-year wireless contracts service providers, offering subsidies has also dented industry sales.

According to IDC , the biggest six in the league, Samsung, Apple (NASDAQ:AAPL), Huawei, Lenovo, Xiaomi, and LG are most exposed to a rapidly maturing market. As the market slows, these vendors are becoming increasingly reliant on share gains to sustain growth. The rapid saturation of the world’s biggest smartphone market, China, may remain a headwind to revenue growth for smartphone vendors as other faster-growing markets such as India remain too small to offset a slowdown in China.

Has iPhone Sales Reached Their Peak?

Amidst intensifying competition and rapid saturation of lucrative markets that once promised high penetration, Apple’s iPhone sales may have hit their peak. With the iPhone accounting for about two thirds of Apple’s total revenues, and unit sales declining in the third quarter, the company now seeks growth through new products and services such as Apple Music, Apple Pay and Apple Watch.

With iPhone sales declining, margin pressure is now a risk for Apple as it loses the volume manufacturing efficiencies associated with higher unit shipments. Near term challenges include pressurized margins, declining unit volumes, currency headwinds and new product launches teething problems. With Apple likely to introduce more product-line extensions and enter new markets to revive growth, margins are likely to remain under pressure, given that new products are less profitable shortly following a launch.
Apple’s gross margin of 40.1% in FY15 trailed BlackBerry’s 46% reflecting the latter’s higher software contribution to sales. Still, Apple boasts better profitability than HTC, LG and Samsung, given its premium smartphone focus, scale and a smaller revenue contribution from lower-margin products. Apple held market share of about 16% last year, in terms of global smartphone shipments, trailing leader Samsung. Apple must leverage on its market leadership to boost iPhone sales through product-line extensions and upgrades.

Apple Is Constantly Looking To Diversify Out Of Hardware

Apple’s biggest risk in beating its rivals is running out of new hardware segments to exploit. Apple’s new launches such as Apple Pay, Apple Music, CarPlay and possibly a streaming video service signal that it is working to diversify into new services with higher growth potential.

However Apple still banks on a hardware heavy business model, with iPhones, Macs and iPads generating about 85% of total sales. While services, apps and other sales are growing faster than Apple’s core products, they’re still too small at 15% of revenue to make up for any meaningful shortfall in iPhone sales. The slowdown in iPhone sales is weighing on the company’s growth potential. Other hardware segments including Macbooks and the iPad contributed an additional 21% of sales. Services and Other Products accounted for the remainder.

Apple Is Preparing To Go To Court Alongside The Irish Government

Customary of any technology company, Apple is quite involved with legal issues that can have a material impact on its financial performance. Protecting the privacy of consumers and any unique features, avoiding unprecedented tax liabilities, and ongoing patent infringement fights with other players in the industry are the legal battles that Apple constantly has to contend with. Apple avoided compromising the iPhone’s security features in its legal fight with the FBI, though the case may stoke future privacy concerns. Apple’s patent cases with Samsung are nearing their end, with Apple defending against claims that patents covering the iPhone’s design are overvalued.

In addition, in what came as a major blow and an unexpected contingent liability, on the 30th of August, the EU demanded $14.5 billion in retrospective taxes from Apple. Ireland and Apple will fight the European Commission’s finding that the company must pay the Irish back taxes. A three-year investigation by the commission found Apple’s “transfer pricing” arrangements with Ireland helped Apple lower its tax liability in violation of the union’s state-aid rules. The investigation probed the arrangements that shelter the iPhone maker’s global revenue in Ireland, and how it was taxed under two Irish rulings from 1991 and 2007.

Takeaway

Apple’s products are priced and marketed for the premium segment. Prior to the launch of the mid-priced iPhone SE, Apple refused to move down market in order to protect its aura of exclusivity and premium brand. With growth in the high-end slowing, Apple is growing more reliant on share gains to drive iPhone sales growth. It gained share with the September 2014 launch of the large-screen iPhone 6 and 6 Plus, but needs to replicate this success with future upgrades to sustain growth in the iPhones.

Apple’s recent market-share gains in the premium smartphone segment were largely driven by 30% iPhone unit growth in calendar 2015. This growth was well above the 6.7% growth in the high-end segment, as Samsung, HTC and Microsoft all lost market share.
Apple’s over reliance on iPhone and slowing growth in the segment has prompted investors to expect the launch of a new franchise that will help sustain Apple’s market share. Currently, it is unlikely that Apple embraces inorganic growth options. Also, Apple does not have near term plans to enter augmented and virtual reality and content. It’s more likely that a number of products and services will play the role of a savior, including Apple Watch, Apple Music, Apple Pay, content and apps. Apple also holds plans to expand into social networking, starting with content sharing apps developed for iPhone and iPad. This development effort reflects Apple’s ongoing investment in its ecosystem to maintain a competitive edge over rivals that are confined to competing largely on hardware features.

Its all about the ecosystem with Apple. Furthermore bears who had written off this stock got an unwelcome surprise in its recent set of Q3 earnings when the company beat earnings estimates. I for one don’t think this stock has finished rallying. Let’s see if it can keep its momentum going..